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Economics – Markets – Strategy
Economics: China
There is considerable academic evidence that the rising value of the CNY tends
to reduce imports rather than to increase them. Econometric estimation of China’s
import elasticity always results in a ‘negative’ sign in studies from organizations
like the World Bank, the IMF and the BIS. These studies reflect the dominance of
‘processing imports’ included within China’s total imports (more than 50% in
2007) as well as the ongoing vertical integration with the rest of Asia. So tradable
goods produced by Asian economies complement China’s exports to a greater
extent than substitutes. Put simply, if exports decline due to a strengthening
CNY, this will be counteracted by a corresponding reduction in imports.
CNY appreciation
tends to reduce
imports, rather
than to increase
them
Does CNY appreciation slow inflation?
The claim that inflation can be tamed through currency appreciation is increasingly
unconvincing. Headline CPI averaged 8.0% YoY in 1Q08, up significantly from
2.7% in 1Q07. Both inflation indices, CPI and PPI, have shown highs of 8.5%
YoY and 8.1% YoY respectively in Apr 2008 despite the faster pace of currency
growth (Chart 2). Indeed, evidence suggests little relationship between them
since Jul 21, 2005. NEER shows that CNY only grew 5% between Jul 2005 and Apr
2008. In real effective exchange rate or REER terms the figure is around 9%
(Chart 3).
Chart 2: Inflation
% YoY
11
CPI
9
7
PPI
5
3
1
-1
-3
-5
Latest: Apr08
-7
Oct-99 Feb-01 Jun-02 Oct-03 Feb-05 Jun-06 Oct-07
Chart 3: CNY REER
Indexed 2000=100
125
120
115
110
109
105
100
95
90
85
80
75
1990 1993 1996 1999 2002 2005 2008
Food and energy prices are still the wild cards
It remains unclear, however, whether inflationary pressures will result in the CPI
falling below 5% YoY in 2H08 from 8% in 1H08. At this time, many economists
predict that prices will start to stabilize in 2H08, basing their arguments on the
‘high-base’ effect carried over from 2H07. However, the Sichuan earthquake
tragedy may put upward pressure on food prices over the next few months as
pork, rice, wheat and corn account for 10.4%, 7.3%, 4.2% and 3.5% respectively
of the nation’s gross output.
Even if consumer inflation stabilizes, the currency can’t do much until food
supplies return to normal. A stronger CNY will not help to lower food prices
when shortages are due to domestic factors. CPI-based inflation in 2H08 looks
set to range within 6.0%-7.0% YoY compared with 8% in 1H08. And inflation
for the whole of 2008 could be at least 6% YoY - much higher than the official
projection of 4.8%.
Even if CPI
stabilizes,
normalization of
food supplies will
take more credit
than the currency
factor
71